IMF Calls on China to Halve Industrial Subsidies

The International Monetary Fund (IMF) has urged China to reduce its industrial subsidies, which currently account for around 4% of the country’s GDP. According to the IMF, these subsidies create a 1.2% drag on total-factor productivity (TFP) and distort resource allocation.

Short-Term Impact

The reduction in subsidies is expected to have a short-term negative impact on GDP growth, with a potential decline of 0.2-0.4 percentage points. This is because the removal of subsidies will immediately reduce the cash flow to state-owned and heavily-subsidized firms, leading to a contraction in investment and a scaling back of projects by local-government financing vehicles.

Medium to Long-Term Benefits

However, in the medium to long term, the removal of subsidies could lead to higher productivity, lower misallocation, and stronger domestic demand. The fiscal space saved from reducing subsidies can be redirected to social welfare programs and to stabilize the property sector, which are flagged as the main domestic risks. The IMF expects that the economy can achieve a higher growth trend, with a potential uplift of 0.4-0.6 percentage points in the long-run growth rate.

Conclusion

In conclusion, while the reduction in subsidies may have a short-term negative impact on GDP growth, the medium to long-term benefits of higher productivity, lower misallocation, and stronger domestic demand are expected to outweigh the costs. The IMF’s recommendation to halve China’s industrial subsidies is a step towards promoting a more sustainable and consumption-led growth model.

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